Investment Fees Will Cost You Millions

[Editor’s comment: This is a republished post from Physician on FIRE, a member of The White Coat Investor Network. This post is yet another illustration of why I use Vanguard index funds and why it can pay millions in retirement to be an educated DIY investor. The original post ran here, but if you missed it the first time, it’s new to you!]

Investment Fees Will Cost You Millions

Yes, Millions.

You don’t have to be a big shot for this to be true. In fact, someone investing $833 a month into his 401(k) can see an 8-figure sum (that’s $10 million) disappear over the course of a long lifespan. Today, we will pry into the finances of four people you may encounter at the hospital and discover the net worth they might expect to have over the course of their working and retirement years.

None of these fees are mandatory, although the only way to avoid the first one is to completely avoid mutual funds and ETFs. The other 4 categories of fees can be avoided by staying away from fund companies that charge excessive fees and managing your own portfolio. As a DIY Investor, I managemy own portfolio made up almost entirely of Vanguard admiral funds, and the total annual fees are a shade under 0.1%.

To take a closer look at the effects of a range of fees on portfolio performance, I’d like to introduce my four friends. We’ll call them Agnes, Agatha, Jermaine, and Jack.

Jack, the Nurse

Jack is a registered nurse. He likes his overnight shifts and early morning happy hours.

Jack has no desire to retire early. He enjoys life and invests enough into his 401(k) to receive the employer match, plus a little extra. At the end of each year, he’s got $10,000 invested, and he does this for 40 years from age 22 to age 62 when he retires.

To keep the calculations reasonably simple, we need to make some assumptions. In order to look at total dollars accumulated, we’ll use nominal (not adjusted for inflation) returns, assuming 8% during working years, and 5% returns with a lower-risk portfolio in retirement. In retirement, Jack will draw $60,000 a year from the portfolio to live and pay taxes. Both his investments during working years and withdrawals in retirement will be made at the beginning of each month.

We’ll look at a realistic range of fees, from 0.1% to 3.0%. When working with reputable advisors,Personal Capital found a range of 1.06% to 1.98% in total average annual fees. Less reputable advisors could add another percent or so on top of that with loaded funds, frequent buying and selling within your account (a.k.a. churning) and hidden fees.

By investing $10,000 a year for 40 years, Jack can expect to amass anywhere from $1.28 million to $2.84 million, depending on fees. That’s a difference of $1.56 million dollars available at retirement. The DIY plan with 0.1% in fees grows to be 122% larger than the 3.0% fee plan.

And that’s not the half of it.

Continuing on into retirement, keeping spending constant at $60,000 a year, if Jack lives to be 100, he could have an 8-figure portfolio with the lowest fee structure. Or he could be out of money before his 90th birthday. If he survives to age 102, the difference between 0.1% fees and 3.0% fees exceeds $13 million!

If we were to account for inflation, Jack’s spending would likely increase progressively throughout retirement, although at some point, spending tends to decrease as the more adventurous travel days are behind him. Of course, long-term care could greatly increase his annual needs. Long story short, we don’t know what to expect, but in the most realistic scenario, due to inflation, Jack would be more likely to run out of money even earlier in the scenarios with high fees.Here’s a look at Jack’s balances if he increased spending by 25% in each of the first 2 decades of retirement and then held steady.

Jack’s spending in this scenario will be:

$60,000 from age 62 to 72

$75,000 from age 72 to 82

$93,750 from age 82 to 102

Well, the numbers have changed, and it doesn’t look any better for the high fee scenario in this somewhat more realistic version. The difference between the savvy DIY investor and the investor with high fees is still about $13 million if he gets to be a centenarian.

Agatha, the Psychiatrist

Agatha is a psychiatrist employed by the hospital. She enjoys plush leather chairs and just listening.

Getting a later start, Agatha will have a shorter career than Jack, but retire at the same age of 62. For 30 years, Agatha will be investing $50,000 a year into tax deferred retirement plans.

She will receive the same investment returns as Jack, 8% while working and 5% in retirement. Her retirement spending will be a loftier $100,000 annually.

Agatha’s 30 year career as a psychiatrist

Agatha builds up a larger nest egg than Jack, but by virtue of larger retirement spending, she is at a greater risk of depleting it. Again we see the ginormous disparity between fees of 0.1% and fees of 3.0%. Again, the difference exceeds $13 million if Agatha gets off the couch and does some cardio, giving her a fighting chance to live to 102.

Jermaine, the Surgeon

Jermaine is an orthopedic surgeon in an independent group. He enjoys “bone broke” & “me fix”. That’s a BBMF for those keeping score at home. [I kid, I kid…]

Jermaine, who had to be one of the top students in his medical school class to land a spot in ortho, is quite savvy with his finances. He works hard, but doesn’t want to do so forever. Like the PoF, Jermaine hasFIREplans of his own, and plans to work a twenty-year career, retiring at 52.

fees (and fawns) can come back to bite you

For 20 years, he invests $150,000 a year, with $50,000 tax deferred and $100,000 in a taxable account. In this scenario, his taxable investments will experience tax drag.

Assuming a buy-and-hold portfolio with a 2% annual qualified dividend (similar to Vanguard’s Total Stock Market or S&P 500 index funds) and a 30% total tax onqualified dividends, his taxable account sees a tax drag of 0.6%, so the overall portfolio will experience a tax drag of 0.4%. (We’ll ignore the small amount of drift the portfolio would see as the tax deferred portion grows at a slightly quicker clip.)

Compared to our first two friends, the investment returns will be the same (8% and 5%) but we’ll subtract 0.4% from those before subtracting fees in our calculations. Retirement spending will match his earlier savings amount, $150,000 a year.

Jermaine’s 20 year career as an orthopedic surgeon

Twenty years of solid investments make Jermaine a wealthy individual. $5 million to $7 million at age 52 depending on fees. What happens in retirement? If the good doctor eats well and exercises like he did as a standout collegiate gymnast, he too might make it to 102. At this point, he might have $37 million or be flat broke. It depends entirely on the investment fees.

“he might have $37 million or be flat broke. It depends entirely on the investment fees.”

Agnes, the Executive

Agnes is the CEO of a large multi-state health system. She worked her way up the ranks and bounced from one time zone to another for decades to find herself in this enviable position. Her monthly salary dwarfs her friend Agatha’s annual salary. Agnes enjoys endless meetings and flushing caviar down the toilet just because.

Agnes becomes the CEO at age 52, and invests a cool $1 million per year, $50,000 into a tax deferred account and the remaining $950,000 into a taxable account. With only 5% tax deferred, we will factor in a 0.55% tax drag on the account. She will retire in 10 years at age 62, spend a lofty $400,000 in a luxurious retirement, and the assumptions on investment returns remain the same.

Agnes’ 10 year career as the CEO

The brief accumulation phase is good to Agnes. She will have $12.6 million to $14.8 million depending on fees. If those fees persist into retirement, we see the gap widen tremendously, to $15 million at age 72, $25 million at age 82, $40 million at age 92, and better than $60 million at age 102, at which poor Agnes with the 3.0% fees finds herself several million dollars in debt, while the ultrarich Agnes with 0.1% fees has enough money to name her alma mater’s new football stadium after her favorite cat.

Learning how to invest pays, and that’s a fact. Just ask my friends Agnes, Agatha, Jermaine, and Jack. If you already know what you need to know to manage your own portfolio, strong work!

If not, the sooner you get started, the sooner you will find yourself on the path to real wealth and freedom.

Would you like to enter your own data into a spreadsheet like you see above? Check out the customizable Fees Effect Calculator on theCalculators page. Or just plug in some numbers right here.

Do you know what you pay in fees? What fees do you see as justifiable? Would you rather end up with an 8-figure portfolio or be flat broke? It’s a silly question, but many people make choices that are more likely to make them the latter.

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35 comments

“But, wait, I make much more for my investors than they would make on their own!”

“I provide special access to products that they would not have on their own!”

“Investing takes a lot of time. You medical people don’t have time for this. You need to be out there saving someone’s life.”

I think the second (and just as important point) is that investing can be very complicated, but it doesn’t have to be. The returns you are reporting above should be easily attainable (6-8%) with passive index fund investing which doesn’t require a giant wealth of knowledge. That is the part that usually scares people I know into high fees. “I don’t have the time and it’s too complicated!”

This, of course, is hogwash. Your post gives all the encouragement one should need to get out there and learn just enough about this stuff to become a DIY investor.

Yea, I got an email like that today from an advisor. They really like those studies Vanguard and Morningstar did in the last year or two about the value of an advisor. But the truth is that the value of an advisor is highly variable, not only between advisors, but between clients. I have no doubt that some advisors can provide some clients 10% a year worth of value. But that doesn’t mean any advisor can provide any client value. In fact, as time goes on, the value a good advisor can provide MUST go down, simply because the initial advice is the most high yield advice.

Wow great post Jim! When you lay the numbers out like that and give examples that really hammers the point home. Kudos. The differences in each one of those examples is staggering. And I think it would be important to remind folks that much of the money in those fees goes towards a wealthy broker living a high-end Manhattan lifestyle. Not that they’re evil people, but it’s unnecessary.

my plan is to get rid of my fee based financial advisor and switch all three accounts (individual, roth and solo K to vanguard), I invest through Baird, they will charge $150 dollars per account so that’s $450 dollars.

My goal is to put these three accounts into vanguard index funds, currently none of the mutual funds are in vanguard funds.

My individual investment account has 8K. (spread over 4 mutual funds and 3 taxable bond funds)
the roth has (7 mutual funds)
solo K has a variety of mutual funds and bonds as well
not interested in an “in-kind” transfer some of these ETFs have high expense ratios, I wanna simply this and take control of my money

I know that vanguard is going to charge me for selling each “non-vanguard fund”

I think cashing out the individual investment account (8K) and paying the capital gain taxes will cost more than vanguard charging me to sell each mutual fund

Your main fees will be the account closure fees. The sell commissions will be relatively low, but you can minimize them by seeing what they are at your current provider and what they are at Vanguard and if they’re lower at Vanguard, transfer in-kind, then sell. Your biggest cost may be the capital gains taxes, so focus on minimizing those (at least considering waiting until they’re all long-term.)

i think a transfer in kind probably does make the most sense, I can understand paying capital gain taxes for my individual investment account. Correct me if I am wrong but I should not be on the hook for capital gain taxes when I am selling my non vanguard funds in my 401 K and roth to purchase vanguards funds in my new retirement plan.

Many would assume a couple percent might only affect their portfolio by a couple percent. How wrong they are. I’ve read a couple of Bogle’s books. He explains and illustrates points like this very well.

Excellent post! I like that you have different examples to relate with. My numbers match up closely with Agatha. I’m lucky to have the TSP which had fees of 0.033% last year and my Vanguard Admiral shares fees are 0.04%. Learning about the various fees years ago from your site is why I fired my Northwestern Mutual “money guy” and started managing things on my own. Thanks again! You definitely deserve all the rewards this site has provided you!

Agree completely. However, a significant portion of my assets are tied up in legacy higher cost mutual funds and ans some with a money manager. The liquidation tax cost ( lots of capital gains) to convert to low cost index funds may be greater than the fee savings. Any calculators to help with this decision? Once I retire, our tax rate may be lower and conversion to lower cost funds may be less costly.
I’m not sure what’s worse higher cap gains taxes now and therefore less money to grow or higher fees.

I had a bit of an issue with some legacy funds, as well, although probably not with the gains you’ve had. I started a taxable account with T. Rowe Price in 2010 and picked some of their “funds of funds” which included some active management and turnover, producing unwanted capital gains in taxable.

T. Rowe Price was one of two companies recommended by Tobias in The Only Investment Guide You’ll Ever Need, but a few years later, I realized I would have been better off choosing the other one (Vanguard).

Looking at the quarterly statements and 1099s, I realized the funds I owned were generating a tax bill of 5-10 times what I would be paying on a passive index fund with a 2% dividend. I sold some (we bought a house around that time with cash from the proceeds) and donated the rest to a donor advised fund.

I don’t know of a specific calculator, but look at your 1099s from 2017 and do your best to estimate what you’re paying in both taxes and fees each year. Compare that to what it would cost to sell them all. If you’re close to retirement, it could make sense to wait. Donating the shares (directly or to a DAF) is another way to avoid the cap gains taxes (but you also give away the basis).

You’re right that it’s a dilemma. A lot of times you can and should build a reasonable portfolio around those legacy funds with low basis. I think it’s too complex for a simple calculator. I would simply sit down with your desired asset allocation and your current holdings and write down their basis and how much it would cost you to get rid of each one, and then consider what you would replace it with and how different that is. Some of the decisions will likely be obvious (definitely get rid of this and definitely keep that) but some will likely be tough. The good news is the tough ones don’t matter as much.

However, in my case and I’m sure many other readers, our assets are tied up in legacy ( non-retirement) mutual funds or high cost money managers with large embedded capial gains. Selling these funds and converting to lower cost index funds causes two investment problems .

1. Initial capital gains taxes when these high cost funds are sold .
2. After paying taxes, there is less money to invest and a subsequent loss of the effects of compounding.

Once retirement occurs, tax rate might be lower and capital gains hit would be less.
Anyone aware of a calculator that might help with this decision?

An excellent analysis. I did a similar analysis and made a calculator for the Canadian setting. We had a bit more tax to account for that I built in. Also, for an AUM fee here you can deduct that against your top marginal tax rate reducing the effective cost of an advisor by 54%. That would make an effective fee of 0.25-0.5% when that is accounted for in a million plus portfolio. The value in that fee would be for the other financial planning more so than portfolio management. You would need to choose an advisor wisely for that component if going that route – as pointed out on WCI in multiple places. You can’t deduct mutual fund fees here. All that aside, the conclusion was the same. If you factor the time to manage a passive portfolio and learn how to make a financial plan, it pays better per hour than anything else I could do in medicine.

“Also, for an AUM fee here you can deduct that against your top marginal tax rate reducing the effective cost of an advisor by 54%”

That really changes the math for you guys and gals north of the border. While working, that’s a hefty deduction. But when you retire (and your portfolio is the largest), I would guess your marginal tax bracket is likely to drop significantly. I don’t know if you can it down to zero like we can (https://www.physicianonfire.com/the-taxman-leaveth-taxes-in-early-retirement/), but I bet it can be much lower than 54%, effectively raising the cost of that advisor.

Best,
-PoF

p.s. On behalf of the state of Minnesota, I’d like to apologize for our substantial role in snatching Gold from Canada’s clutches in both women’s hockey and men’s curling. I am truly sorry for our victorious behavior.

You are exactly right. While earning a big income, it makes an advisor more viable for us than it would be otherwise. Also, our tax complexities and aggressive rates probably mean a good advisor may save some money with creative tax planning. Either way, taking the time to learn to DIY or manage your portfolio with some defined specific fee-based advice can save a bundle if you put in the effort. With a large portfolio and little earned income (like in retirement), that would change dramatically favouring a DIY approach and most of the tax planning etc would already be done in advance of that. We would have a hard time getting our taxes down to zero. Part of that is our aggressive tax system and part of that personally is that we are admittedly spendy when it comes to hobbies etc. I already find myself spending more on those now that I work less.

At the risk of deportation, I do need to confess that I did not follow the hockey. However, everything that I heard was that the U.S. team deserved the win. I should probably stay anonymous 😉

They actually did deserve it. The US women dramatically outplayed the Canadian women during the third period and the 20 minute sudden death 4 on 4 overtime. Probably outshot them 2-1. Very competitive shootout too. Really a game for the ages.

and don’t forget about the variable costs of trading expenses that do not even have to be disclosed in mutual fund prospectuses because they don’t know until the end of the year what they will be. when you add investor instincts to this expensive stew you can get massive involuntary additional costs (and 1099’s)

when you add all the layers up for advisor led funds it’s like asking your savings race horse to run with a 314 lb. jockey

jim’s followers are so well-served by his analysis which is better on more topics than wall street advisors are even allowed to communicate about

As Ken says, Bogle also describes this tyranny of compounded costs, which is essential to consider. It is interesting to note that Bogle is forecasting returns of 4%, rather than the 8% used in this article; so be careful when running your numbers.

As WCI suggests, DIY is the best approach, but I would guess the majority of doctors are not willing or able to do so. The simple answer for these individuals is to minimize or avoid all costs that are based on a percentage of assets. That means investing in low cost passive funds, avoiding loads, 12-b1 fees, etc, and avoiding any financial advisor who bases his fee on a percentage of AUM. Plug in hourly rates or hourly-based fixed fees into this model, and you will find an enormous decrease in costs.

It’s certainly possible to have fees under 1%, particularly when using a flat-fee or hourly rate advisor and all the responsible investing choices you’ve outlined above. That’s way better than you’ll do with the 2% or more that some of the common storefront salespeople masquerading as advisors will rack up in fees for you.

Regarding future returns, 4% is what Bogle predicted for the next decade, not a lifetime. And that was about 18 months ago. Given the gains we’ve seen since then, his outlook today might be tempered a bit more.

Also, please note that I’m not predicting returns, just using 8% while working and 5% while retired to be able to come up with one possible scenario. These returns are below historical averages, but could very well be better than we see over the short-to-medium term range going forward.

It’s not just the possibility of fees under 1%. Ultimately it should come down to whether the individual wants to DIY or hire an advisor for, say, $200 an hour. If handled properly, that advisor fee should be the only cost in excess of the DIY costs. It is not unreasonable to expect that many doctors believe that their time (and avoidance of aggravation) is worth more than $200/hr.

Using averages is a good way to illustrate this particular point, but I also took “Jack’s” accumulations at 62, along with his costs, and plugged them into Firecalc using a 30 year period and the $60k initial spend for all of the cost scenarios. With costs of 0.1, 0.5 and 1.0% he had no failures to his plan (100% success) to age 92. At 1.5% costs his success rate was 97%. At 2% costs the success rate dropped to about 75%. At 2.5%, the success rate was 50%. Finally at 3%, the success rate was only 30%. Obviously this is a function of both how the initial withdrawal rate varies due to accumulation period costs along with the impact during the spend-down period, but it represents one more way to look at the benefits of lower costs.

Further, if Jack arrives at 62 with only $1.28M due to having paid costs of 3% for 40 years, he can use his free time to shift those investments to a portfolio with costs of 0.1% and increase his odds of success from the dismal 30% to about 71%. So, in some respects, it may almost never be too late to make an improvement.

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